Equity and Distributional Issues in the Design of Environmental Tax Reform

Many politically active groups are looking to environmental tax reform (ETR)2 as they seek to solve environmental and social problems. The use of market mechanisms, rather than the more common “command and control” system of regulation (“thou shalt not . . .”), is becoming increasingly popular because it can be more efficient and offers greater flexibility. But since lower-income households spend a greater percentage of their income on basic necessities, which tend to be more resource intensive than luxury goods, some people who might otherwise support ETR are hesitant because of equity concerns. But ETRs need not purchase environmental quality at disproportionate expense to lower-income groups. To have a productive discussion about equity concerns, one must first specify the details of the ETR under consideration. The variety of ETRs that could be implemented at the federal, state, or local level is enormous. Energy, water and wastewater, solid and hazardous waste, and land and structures offer interesting and complex opportunities for user fees or environmental taxes. Income, payroll, property, sales, utility, and other existing taxes or government charges (for example, municipal business license fees) could be reduced. This paper shows that well-designed ETRs need not be regressive. We begin by discussing regressivity. What are the various ways of measuring it? Are some methods better than others, and if so, why? We explain eight ways that one might estimate regressivity, and explain why only two of the eight are useful for the design of practical, politically feasible ETRs. Second, we discuss the three ways that ETRs can be designed to prevent regressive equity and distributional impacts, or in some instances to increase the progressivity of the tax system. We believe that this information will increase the credibility and persuasiveness of ETR advocacy efforts.